Taking Away the Punch Bowl with a Vengeance

From the looks of today’s stock market action, I’d guess that a lot of traders are still working off that New Year’s Eve hangover from last week. Yes, I was expecting a sell-off in January (six weeks ago I said as much in this column: “Black Friday in Reverse”) due to the window-dressing run up that usually occurs in December, but I didn’t expect portfolio managers to start reorganizing their portfolios quite so quickly.

On the other hand, I can’t say that I’m totally surprised, either. We are clearly entering into a pivotal point for the U.S. stock market since the Fed can no longer justify continuing its Quantitative Easing program in the face of accelerating GDP and decreasing unemployment. The easy money of the past three years is going away, to be replaced by gradually rising interest rates and a stronger dollar.

Combined with plummeting oil prices which signal an absence of inflation, you have the ingredients for a stock market that will behave very differently going forward than it has in the recent past. The key question now becomes, exactly how will the stock market behave differently, and how can you profit it from that knowledge?

The first thing you need to understand is that while today’s sell-off is indiscriminate – pulling down just about every stock being traded – what we are really entering into is the two-tier stock market I have been predicting all along. That means that once the current round of “blow off” selling is complete, investors will become more selective in the stocks they buy and sell.

In short, my expectation is that the stock market will become a zero-sum game in 2015, with a stagnant amount of cash chasing after the most attractive stocks. And if cash begins exiting the stock market, then it will become a minus-sum game of musical chairs that quickly exposes those companies with inferior revenue models and flimsy product launches.

So who are the big losers in this type of market environment? Clearly, the so called “momentum stocks” trading at very high multiples are most at risk. That’s why in last week’s issue we initiated four new short sell positions (see Alert), as we feel these stocks are most likely to suffer from excessive PER multiples. Of those four (Adobe Systems, Autodesk, LinkedIn, salesforce.com), LinkedIn and salesforce.com curently trade at more than 100 times estimated forward (12 month) earnings so they are most at risk in the near term.

But eventually all stocks that can’t support the outsized expectations of big earnings many years into the future will be brought down. Quite frankly, in this new market environment we feel any company with an STR (Smart Tech Rating) of less than 2.0 is very likely to take a big hit, so if you are looking for additional short sale candidates then you can peruse our Smart Tech 50 table and sort according to the STR column to see who they are.

Meanwhile, Rob DeFrancesco’s pick of FireEye (FEYE) last month as “The One Tech Stock to Own in 2015” is one of the few stocks posting a gain today (up more than 3% on a day when the overall market is down more than 1%!). Rob has displayed a magical touch with his Next Wave portfolio selections, and he has his “fire eye” on a couple of names that he feels are close to being good buys including the one highlighted in his Next Wave Portfolio Update article below.

NASDAQ Composite Index:                                                                        

Friday, January 2 = 4,726.81                                                   

Trailing 12 months = + 14.1%                                        

Trailing 7 Days = – 1.9%                                       

Trailing 4 Weeks = + 1.8%

Next Wave Portfolio Update—One to Watch: Imperva

By Rob DeFrancesco

We are fast approaching earnings season once again. Fourth quarter results are right around the corner. Following the overall market rebound from the October pullback, many tech stocks have returned to trade at elevated valuations, which increases risk levels going into the December quarter results.

A lot is riding on guidance for the first quarter, too. If the conference calls covering Q4 results take on a more conservative tone with respect to business in Europe or currency headwinds, money managers could see any cautiousness as reason enough to trim positions, causing a pullback across the tech space.

If we were to get some degree of a market correction over the next few months, some names I am watching stand to become more attractive from a valuation standpoint. One is Imperva (IMPV), a provider of datacenter security solutions.

The stock, recently trading at $48.46, has been on a rollercoaster ride. After reaching an all-time high of $67.12 last March, shares of Imperva over the next two months plunged more than 72% to $18.40, and then in late December rebounded to a high of $53.35.

The culprit for last year’s sharp retreat in the stock: The company flubbed Q1, reporting a 15% drop in product revenue, with the blame put on extended large-deal cycles. It really came down to sales execution issues (managers across all levels—even the CEO—lost focus) mixed with intensified competition from main adversary IBM (IBM), which used a variety of tactics to stall bake-offs on deals over $100,000.

Since then, a lot of positive changes have been made across the executive and regional sales ranks. Credit must be given to Imperva management, which quickly made the necessary moves to get back on track, including hiring a new CEO. Things started to improve in Q2, thanks in part to the appointment of a new head of the Americas sales region; product revenue rose 5.7% from the year-ago period.

All field operations were aligned into one organization, providing better synergies across the company. New operational processes were put in place to improve execution and visibility. The Q2 earnings conference call had a much better tone even though sales cycles were still extended. Going into Q3, the company boasted a record pipeline.

In the middle of August, Imperva named Anthony Bettencourt as the new CEO, moving Shlomo Kramer (founder and former CEO) over to the newly created post of chief strategy officer. Bettencourt is a solid addition to the team because he is an operations-focused leader, with 25 years of experience building, running and selling high-growth tech companies. While founders have the entrepreneurial talent to get things off the ground, they often lack the operational skills to keep things afloat.

In Q3, revenue rose 21% to $42.7 million, coming in above the consensus estimate of $39.9 million and the high end of the guidance range of $38 million to $41 million. Product revenue growth accelerated to 8.1%. Product and subscription revenue combined (a key metric) rose 23% to $26 million, driven by 108% growth in subscriptions to $6.4 million, representing 15% of total revenue (up from 9% in the comparable quarter last year). The company added 183 new accounts (+24% year over year) and now has more than 3,500 customers in 90 countries.

Revenue guidance for 2014 was raised to a range of $161.2 million to $163.2 million (growth of 17% to 18% year over year) from $155.5 million to $162.5 million previously. For 2015, the consensus revenue estimate of $199.5 million indicates growth of 23%. With its operations house back in order, Imperva is again well positioned to benefit from strong demand for database and Web application security solutions.